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Cause for Concern: Causation and Federal Securities Fraud Jill E

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Cause for Concern: Causation and Federal Securities Fraud Jill E FISCH_FINAL 5/13/2009 10:37 AM Cause for Concern: Causation and Federal Securities Fraud Jill E. Fisch ABSTRACT: The Supreme Court’s decision in Dura Pharmaceuticals dramatically changed federal securities fraud litigation. The Dura decision itself said little, but counseled lower courts to fashion new requirements of causation and harm modeled upon common law tort principles. These instructions have led lower courts to craft a series of confusing and inconsistent decisions that incorporate little of the reasoning upon which the common law principles are based. This Article accepts the Dura challenge and examines both common law causation principles and their applicability to federal securities fraud. In so doing, the Article identifies the failure of the federal courts to confront properly the complex causation challenges presented by securities fraud and the extent to which common law approaches to multiple and indeterminate causation offer guidance. Common law causation analysis further highlights the critical issue of harm specification. The Article demonstrates how, from Basic to Dura, the Supreme Court has refused to address the issue of what constitutes an appropriate economic loss, despite the fact that this determination is a necessary predicate to formulating a causation requirement. The Article goes on to show how, in Basic, the Court shifted the nature of actionable harm and, in so doing, exacerbated the complexity of causation analysis. Professor of Law, University of Pennsylvania Law School. Much of this Article was written while the author was the T.J. Maloney Professor of Business Law, Fordham Law School, and Director of the Fordham Corporate Law Center. Copyright 2009 by Jill E. Fisch. I am grateful to Paul Miller for helpful conversations, to Jennifer Arlen, Bill Bratton, Victor Brudney, Allen Ferrell, Jesse Fried, Jeff Gordon, Marc Gross, Elizabeth Nowicki, Dan Richman, Cathy Sharkey, Richard Squire, Jane Stapleton, David Tabak, and Ben Zipursky for probing comments on earlier drafts, and to Sriram Kilapakkam, Columbia Law School LL.M. Class of 2008, for excellent research assistance. I presented earlier drafts of this Article to seminars and faculty workshops at Columbia Law School, Harvard Law School, University of California, Berkeley, School of Law, the University of Pennsylvania Law School, Fordham Law School, UCLA Law School, Boston University Law School, and Georgetown University Law Center. I received many valuable suggestions at each session. 811 Electronic copy available at: http://ssrn.com/abstract=1234021 FISCH_FINAL 5/13/2009 10:37 AM 812 94 IOWA LAW REVIEW [2009] Defining the appropriate harm involved in securities fraud is challenging. Drawing upon tort law principles, this Article considers several alternatives, including artificial price inflation, ex post stock price drop, and increased investment risk. The choice among these alternatives reflects policy judgments about the appropriate goals of private securities fraud litigation. In its final section, this Article considers current critiques of securities fraud litigation and demonstrates how these concerns should influence the scope of the private right of action. I. INTRODUCTION ....................................................................................... 813 II. THE CAUSATION REQUIREMENT IN 10b-5 LITIGATION .......................... 815 A. THE DEVELOPMENT OF THE CAUSATION REQUIREMENT ...................... 816 B. THE DURA DECISION ........................................................................ 823 C. POST-DURA CASES ............................................................................ 825 D. STONERIDGE .................................................................................... 827 III. TORT LAW FOUNDATIONS OF THE CAUSATION REQUIREMENT .............. 829 A. THE CAUSATION REQUIREMENT IN TORT LAW .................................... 829 B. TORT LAW APPROACHES TO CAUSAL COMPLEXITY .............................. 833 C. CAUSAL COMPLEXITY IN SECURITIES LITIGATION ................................ 840 IV. THE HARM IN SECURITIES FRAUD ........................................................... 842 A. ARTIFICIAL PRICE INFLATION ............................................................. 844 B. OUTCOME HARM .............................................................................. 847 C. RISK VERSUS INJURY—ANOTHER VIEW OF DURA ................................ 852 D. NETTING........................................................................................... 858 V. CAUSATION AND FEDERAL SECURITIES FRAUD ........................................ 860 A. SECURITIES FRAUD AND TORT LAW .................................................... 860 B. THE APPROPRIATE SCOPE OF THE STATUTORY FRAUD REMEDY ............ 864 VI. CONCLUSION .......................................................................................... 871 Electronic copy available at: http://ssrn.com/abstract=1234021 FISCH_FINAL 5/13/2009 10:37 AM CAUSATION AND FEDERAL SECURITIES FRAUD 813 I. INTRODUCTION In 2005, the U.S. Supreme Court considered the scope of the loss causation requirement in federal securities fraud litigation. In Dura Pharmaceuticals, Inc. v. Broudo,1 the Court explained that, in formulating the causation requirement, the lower courts should look to the common law for guidance. As the Dura Court stated, the “traditional elements of causation and loss”2 are derived from “common-law deceit and misrepresentation actions.”3 Three years later, the Supreme Court decided another case involving federal securities fraud. In Stoneridge Investment Partners, LLC v. Scientific- Atlanta, Inc., the Court rejected a claim by investors against secondary defendants on the ground that the investors could not meet the reliance requirement.4 In so doing, the Court explicitly rejected an interpretation of the reliance requirement based on common law fraud. According to the Court: “Section 10(b) does not incorporate common-law fraud into federal law.”5 Reliance and loss causation constitute two components of the causation requirement in federal securities fraud, a requirement that the lower courts have refined over many years based on common law tort principles.6 The very terms used by the federal courts in analyzing causation—“transaction causation” and “loss causation”—have their roots in the common law. Moreover, the incorporation of tort law into federal securities fraud extends beyond causation; most of the elements of federal securities fraud draw upon common law torts. Thus, with its two conflicting approaches, the Court has thrown into question a critical interpretive principle. Legal realists might point to Dura and Stoneridge as evidence that the Justices’ desired outcomes dominate principled legal analysis. Neither decision fully analyzes the common law principles at issue, yet both reach 1. Dura Pharms., Inc. v. Broudo, 544 U.S. 336 (2005). 2. Id. at 346. 3. Id. at 343. Detailed causation analysis in common law fraud cases is quite limited. Complex questions of causation are more commonly found in negligence law. For example, Dura cites comment b to section 548A of the Restatement (Second) of Torts, see id. at 344, which contains a brief discussion of legal causation in cases of fraudulent misrepresentation and notes the existence of conflicting authority as to the scope of the defendant’s responsibility. See RESTATEMENT (SECOND) OF TORTS § 548A cmt. b (1977); id. § 548A reporter’s note (1981). 4. Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 128 S. Ct. 761, 769 (2008) (“Petitioner . cannot show reliance upon any of respondents’ actions except in an indirect chain that we find too remote for liability.”). 5. Id. at 771. 6. Congress codified the loss causation requirement as part of the Private Securities Litigation Reform Act of 1995 without defining loss causation or evidencing any intention to depart from the existing judge-made definition. See Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, sec. 101(b), § 21D(b)(4), 109 Stat. 737, 747 (codified at 15 U.S.C. § 78u-4(b)(4) (2000)). Electronic copy available at: http://ssrn.com/abstract=1234021 FISCH_FINAL 5/13/2009 10:37 AM 814 94 IOWA LAW REVIEW [2009] the same policy outcome of restricting private litigation. In Dura, the Court drew upon tort law to reject the argument that artificial price inflation was sufficient to establish the plaintiffs’ loss. In Stoneridge, the Court rejected tort law in order to dismiss claims against defendants who had not made misstatements directly to investors. Yet, legal realism fails to do justice to an underlying tension in the scope of the private right of action for federal securities fraud—a tension that, this Article claims, is properly understood as the cause of the Court’s schizophrenia. Federal securities fraud is—at the same time—both like and unlike the common law torts upon which it is based. As a result, the nature of the claim and the policies it serves offer reasons both to reject and to embrace analogies to the common law. The context of the causation requirement highlights this tension. A careful analysis of the common law reveals two important issues that the courts’ causation analysis has not addressed. The first is the effect of multiple causal factors. The Supreme Court’s decision in Basic Inc. v. Levinson7 makes it critical to determine the effect of the fraud upon stock price, yet multiple nontortious factors also affect stock price. In considering the legal effect of these multiple causal
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